Morgan Online, 22 February 2012
John Carran, Senior Economist at Gareth Morgan Investments
The GMI investment strategy team has started 2012 in a happy mood and it’s not because of the balmy (or should that be barmy?) Wellington weather. Markets have been in rally mode since mid-December, and we’ve been enjoying the renewed positivity.
But is this a replay of the start of 2011? Back then the rally turned out to be short-lived, as the earthquake in Japan and heightened anxiety over Eurozone financial woes conspired to depress markets in the second half of the year.
This time, we consider the rally has more legs for the following four reasons:
1. The world is awash with cash
Central banks are pumping banking systems full of cheap short-term funding. The US Federal Reserve has undertaken two rounds of massive money printing and has guaranteed to keep the official cash rate at close to zero until at least 2014. The European Central Bank (ECB) has made available unlimited funding for banks for periods of up to three years at 1% p.a. in return for banks’ dodgy collateral.
This massive cash boost substantially reduces the risk that banks will get into financial difficulty just because private depositors and other banks are petrified of lending to them.
2. Greece is being ring-fenced
There is growing confidence that the rest of Europe is now inoculated against Greece defaulting on its debts. This is partly because of the extra central bank funding as discussed. But it is also because there is greater confidence that the combined financial resources of Europe and the International Monetary Fund (IMF) will be sufficient to save European banks holding worthless Greek bonds. Backing this up is increasing commitments by Eurozone countries to rein in their fiscal deficits and begin radical economic reforms.
3. The US is not heading for recession this year
Contrary to expectations for most of last year, the US economy is unlikely to fall into recession this year. The economy grew 2.8% in 2011. Economic news has been mostly positive in the past two to three months, generally indicating slow but steady growth in the economy. Manufacturing is the brightest spot. There remain weaknesses in the US economy – the housing market is still sickly and jobs are growing too slowly to give much of a boost to consumer spending. Economic growth is expected to be 2-2.5% in 2012, which is a definite improvement on the 1.5-2% growth being predicted last year.
4. China’s economy won’t crash-land
It appears now that China’s economy, although slowing, will not crash-land. Its latest Gross Domestic Product (GDP) figures for the fourth quarter of 2011 showed the economy grew at 8.9%, significantly higher than the 8.5% or below that many were expecting. Importantly, inflation has cooled significantly. This will allow China’s government to relax credit restrictions in an effort to inject more life into its domestic economy.
This does not mean that all is hunky dory in the global economy and we’re counting down to blast-off.
The problems in Europe are still not settled and there remains a significant risk that Greek default will infect Portugal, Ireland, Spain and Italy.
Austerity will also test the fortitude of the European masses, with the risk of countries back-tracking on debt reduction and economic reforms.
If these factors come to the forefront again then the global outlook won’t look so rosy. But for now the sun is peeping through.